Over the last few years a new type of investing option has emerged namely cryptocurrency. They work on a new set of technology called blockchain. This allows them to offer exchange of such currencies without any presence of a financial party to oversee transactions. Freedom from banking institutions and their ridiculous fees, anonymity, ease of use etc are its advantages. Owing to these benefits, off late they appear to be great investment choices. People have been buying up cryptocurrencies and driving their prices even higher. In this environment, I wish to discuss cryptocurrency as an investing asset or an actual currency and feasibility of this panning out long term.
Brief history of Currency
A currency is system of money. It allows people to trade and exchange goods with in any economy. In ancient ages, people used barter system by exchanging some goods and services in return of other. Then few hundred years ago gold, silver and other precious metals were used as currencies. People could inherently see the value of precious metals. So they became de-facto standard for payment. But paying for services in terms of gold and silver every time you go to a market to buy groceries seemed stupid and had its drawbacks. So, then governments around the world started printing bills that were easy to carry and exchange. These bills were backed by the amount of gold/any precious metal held against it in reserves. This was called the gold standard/commodity standard. Basically, governments could not print money more than the amount of gold reserves it had. This would help in preventing inflation. During this time, you could walk into a bank and hand them all your USD bills and ask to be paid in form of equivalent amount of gold. Read about it here.
Then came the age of fiat currency. Countries needed ability to not just prevent hyperinflation but also allow for deflation. They needed ability to control the flow of money in their own countries. So the Central banks (Federal Reserve, Reserve Bank of India, ECB etc.) in countries decided to step away from the gold standard and started printing their own money. The value of the currency was to be determined by economic activity, imports/exports of the country etc. Central banks guaranteed that the bill they have in your pocket is legal tender and accepted in their country. However earlier when the bill was backed by actual amount of gold held in reserve by the country, now the same bill is backed by the central bank’s words. Trust is the essential aspect in all of this. The central banks say their currency has value and so everyone in the country uses it to pay for services and goods. This value can fluctuate every day based on how people perceive/trust the economic conditions in the country and based on economic data. It is also possible for the value of currency to go down to useless as evident with crisis in Zimbabwe and Venezuela recently. The value of ZWD plummeted, and inflation was so high because of some stupid practices by the government. Zimbabwe had to recently scrap their dollar and country started using USD as its official currency! Having said that, fiat currency standard has helped governments navigate tough business cycles and recessions across the world by limiting/increasing the supply of money.
Cryptocurrency as currency
Let us evaluate cryptocurrencies with regards to the following factors based on our reading of history of currency:
Ease of use/Speed
People moved from using coins and precious metals to notes precisely because of ease to carry it around. It was portable, and anyone can keep it in their pockets. Most cryptocurrencies are completely digital. There is no bill for them. Most transactions are online, done using smartphone and internet connection. This is a big plus. When it comes to speed of transactions, some like ripple(XRP) can take a few seconds, while some like bitcoin(BTC) could take a few minutes for a transaction. So some cryptos can work ok for day to day transactions where as some are not fast enough. I do not want to be waiting for a few minutes in the grocery aisle for checkout to make sure my transaction clears.
The value of a currency needs to be stable. To sell a laptop/any good/service it needs to have a price associated with it. Value of 1 bitcoin was 8218 USD on 8 Feb 2018, 10300 USD on 26 Feb 2018. It changes too fast. The value is just too volatile to keep up with. If there is no stability and trust in the currency how am I to budget my expenses? If let’s say I keep aside 30$ for gas every month which is 0.00365 amount of bitcoins if my gas station accepts it on 8 FEB 2018. Now if the value of bitcoins go up crazy overnight and my gas station only accepts bitcoins, now I need 0.00456 amount of bitcoin to buy same amount of gas on Oct 5 2018. So, it’s just not possible to accurately rely on any cryptocurrencies long term value.
As I mentioned, trust is at center of all currencies in the modern Fiat world. If people did not believe in the backing of Federal Reserve any longer, USD will be worthless piece of paper. So who backs cryptocurrencies? What sort of economic data, import/export activity occurs in form of crypto currencies ? Is there any government that considers any cryptocurrency legal tender? While the idea of kicking it in the face of banks and financial institutions who charge fees to facilitate some transactions, have centralized power to accept/reject transactions seems nice. It does come at the cost of reliability and trust. Its extremely difficult/next to impossible to reverse any crypto transaction. If you get scammed, you’re in trouble. You can not contact anyone or any central authority to try and resolve an issue. With my credit cards and banks, if my package from amazon doesn’t get delivered, I can contact amazon, my bank etc. to reverse transaction. Banks might charge you fees for doing some transactions, but they do work for it. They provide you with a level of trust and reliability for your transactions and charge fee for that. Inherent point of cryptocurrencies providing a decentralized system defeats the purpose of providing a reliable one too.
But my cryptocurrency is an investment!
Let’s try to break this down. So, what is an investment? Hopefully your definition includes you putting in some money in an asset and it increases in value after some time. You expect your asset to return some money in form of dividends and keep growing and making you wealthy in the process. For e.g. let’s consider a stock/part ownership in a public company. A good company will make profits a part of which it might give back to you as dividends. A part of it might be used to invest in R&D make new products and grow more etc. So if eventually you bought a stock in a good company at reasonable value, it will go up in few years’ time since the company is growing. The company is using its own assets to make money and turn a profit.
Let us even look at your house, suppose you buy a house and put it on rent. You invested money to buy it and are now getting paid rent every year to own an asset. It’s working for you to make more money. Your house is an investment asset!
Now let’s look at cryptocurrency from this point of view. So say I invest 1000 USD in bitcoins. Now after I make that investment, why would the price of bitcoins go up? Is there a product that is being sold by Bitcoin? Any income statement being generated at the end of the year, or any dividend I might get by investing in cryptocurrencies? Is there any profit being generated that Bitcoin uses to invest back in its own products etc. ? I do not think so! The value for crypto currencies has increased just because of the perceived benefits like de centralization, no exchange rates etc. Whenever people try to buy cryptocurrency as an investment they are just hoping its demand increase and value goes up. In short they are speculating that they can cash out at a higher price. There is no absolute reason anyone can tell why cryptocurrencies will go higher in the future. My friends, if you want to actually invest, there are far better ways like investing in real companies which are far simpler to understand. They make money, turn out a profit give you dividends invest back in business and keep growing. Why would you not want to invest in a good company rather on a cryptocurrency which you have no idea how people will perceive it in future.
Many failed attempts at using Cryptocurrencies already
Retailers like Dell, Microsoft, WordPress, Expedia started accepting bitcoins a few years back. At that time, it seemed like bitcoin could be used as a legit currency. However, within a few months most of them stopped accepting crypto currencies as a form of payment. They just went mum about it and have never spoken about it again. My guess is It was too volatile, and I can also go ahead and tell you they probably sold all of it already. Check out this article which delves deeper into why these retailers might have stopped accepting bitcoin. I have actually not come across any business or person who actually wants to hold crypto currencies for long term. Even if they accept these coins as legitimate payment, they just want to convert them back to USD or any other currency soon after getting it. Why so? If you believe in the value proposition of bitcoin, why not go long and hodl? Why sell to convert to USD or anything else. This itself shows lack of trust people put in the cryptocurrency network.
Illegal/Anonymous use of cryptocurrency
So far, the only places I have seen cryptocurrencies being used in are mostly illegal! Sites like SilkRoad which allowed you to buy illegal drugs, pirated movies, other activities etc. All these transactions were facilitated using exchange of cryptocurrencies. Why? Simply because they allowed you to be anonymous! You could do anything/buy anything using crypto currencies and no one would know.
Blockchain is the real value
In my opinion crypto currencies are just going to be worthless eventually. Where is the value? Its in the underlying technology. Blockchain as you may know is the actual underlying technology that most of these coins use. It allows them to be decentralized and police each other in the system. Basically, every node in the blockchain has its own copy of the data. It must match all other node’s copies. Its only possible to add new data and not remove anything. So that makes it difficult to forge or try to cheat since you would have to do that on all nodes across the network. I am not going to go into the details of how blockchain works as part of this article. But essentially the tech provides multiple decentralized repositories which are accurate, authentic, verifiable etc. Those are some feature that are highly desired in a lot of applications. I would imagine companies will or have already started building up their applications on top of blockchain concepts. Some example can be:
Supply chain systems
Most companies use a very complex network of suppliers that could ship multiple or just one of the raw materials required in the process. Many companies even have multiple suppliers for same raw material. Currently most of these suppliers and customers only transmit the data to one another using web services etc. But they don’t really keep it in sync, some do not even do this electronic transfer and its just someone doing this manually on one end. Blockchain will be able to provide a real time accurate data of any piece of the supply chain anywhere all the time. Imagine multiple companies in a supply chain coordinating to put all their data on a blockchain. Say for example a farmer, some big company that sources farmers produce as raw materials, creates finished goods/packaged food etc and ships it out to various grocery stores. Now imagine if all this data is shared and in sync between all parties. If a health hazard like E.coli or some disease spreads in a city and is tracked down to one of the products of the company in question. Imagine how easy will it be to track the scale of the issue and take effective steps to prevent or remove the concerned product from shelves. Currently when such a thing happens, most producers are forced to remove everything from shelves, every can of that product from the grocery stores. Maybe blockchain will help them pinpoint the root cause in supply chain instantly! It might be possible to accurately tell which specific farmer’s crops problem and which specific cans had need to be removed from shelves rather than all of it. Imagine the cost savings for everyone from farmers to grocery store operator in the supply chain. Read more about benefits in supply chain here.
Amex Membership Rewards use of Blockchain
Another example is how American Express has recently opened their rewards platform for use on other websites using Blockchain technology. Basically, they have allowed merchants and grocers to advertise their own MR points promos on products they want to move off shelf to customers. Once customers make the purchase, information can travel to amex, retailer and product manufacturer about the purchase. This allows all parties to evaluate how the promotion performed for them. This information ic closely guarded by retailers. But with blockchain this should be available to all parties. This apparently also helps save time to market for promos shortening it from months to weeks according to Amex. This is truly a great use case for using blockchain. Read about it here.
I see use of blockchain in a lot of applications for security, digital fingerprint, or to establish a digital trail in cases that need a lot of security etc. But most of these applications will just use blockchain on backend. A user won’t be able to see any difference on the front end using applications or in doing certain tasks. The application on back end will just be using blockchain tech to be more secure and get more efficient. Due to these issues of scalability, trust and governance for cryptocurrency, I highly doubt cryptocurrencies will ever be adopted for use wide scale. I neither consider them to be fit for use as currencies nor as investments. I could even go ahead and say its possible banks might adopt blockchain as a tech that might help them facilitate faster, reliable quick settling transactions for traditional currency. Instead of the SWIFT tech which takes a few days to settle international transfers.
I would love to hear your thoughts and discuss about cryptocurrency and its future. Please comment below and I will make sure to engage in the discussion.